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Market Bulletin - Warsaw act

Last Thursday, Krasinski square in Poland reverberated with chants of “Donald Trump” and “USA” as the president delivered his first public speech on European soil – a significant moment for any US president. Trump used the occasion to praise Poland, criticise Russia and reaffirm the US’s commitment to NATO. The speech came shortly before G20 leaders gathered in Hamburg for one of the most fraught such gatherings in recent times.

Earlier in the week, North Korea had initiated its first test of an intercontinental ballistic missile – the projectile travelled 930 kilometres before plunging into the Sea of Japan. The test means North Korea has the ballistic capacity to reach Alaska, and last week Pyongyang claimed to already possess the capacity to attach a nuclear load to the device, should it so wish. Donald Trump responded rapidly to say that the US would act “very strongly” in response. The commander of US forces in South Korea made a public statement to say that his forces are prepared for war if needed. China and Russia advised caution.

The Chinese president, meanwhile, warned of “negative factors” at play in Sino–US relations after the US last week sent a navy destroyer steaming past a disputed island in the South China Sea. At the weekend, China sent its own aircraft carrier to Hong Kong.

Markets are more rusty weather vane than precision gauge when it comes to global politics, but indices on both sides of the Pacific struggled over the course of the week. The S&P 500 rose just 0.1%, while the Nikkei 225 lost 0.5% – the MSCI World slipped more than half a percent over the week.

Inevitably, however, there were more familiar forces at play in such moves too. While the S&P 500 struggled early in the week, partly due to fears that second-quarter earnings might yet disappoint, positive manufacturing figures pared back losses somewhat. Friday’s payrolls report offered further uplift – the 222,000 new US jobs added in June was significantly above expectations, although wage growth continued to disappoint. Moreover, while technology stocks have created downward pressure in recent weeks, financial stocks have been moving in the opposite direction.

Another significant player on markets in recent weeks has been the oil price, which is down to roughly where it was 13 years ago and last week took energy stocks down with it. The relationship between the oil price and the broader stock market is not quite as simple, but some comparisons are telling. For anyone who bet on the oil price back in 2004 and has since sat tight, it must be painful to consider the relative performance of equities – the S&P 500 has risen 163% over the same period.

Continued US growth and job increases added to expectations that the Fed will indeed pursue the more hawkish path it has already begun to outline. Treasury yields – which move inversely to prices – rose in response. Fed minutes released on Wednesday showed the Federal Open Market Committee, which sets US interest rates, split over when it should begin to taper its bond-buying. The committee appears more united on planning for rate rises later in the year, however.

Trade ties

While Japanese stocks suffered somewhat over the course of the week, the country could nevertheless boast a significant breakthrough – a free trade deal with the EU, which was signed on Thursday. The timing was presumably set to maximise its impact, but others made their own statements, not least Donald Trump, who pledged a “very quick” US–UK trade deal.

A day later, Markit data showed that eurozone manufacturing had hit a six-year high. Austria, Germany and the Netherlands put in particularly strong performances in the Markit Purchasing Managers’ Indices (PMIs) – Greece also made a return to manufacturing growth for the first time in a year. The Eurofirst 300 ended the week up just 0.1%.

Figures for the UK told a somewhat different tale. A report by the Office for National Statistics showed that economic growth over the past 12 months has been largely the result of population growth (rather than, say, productivity growth). The same report showed that family disposable income has fallen for the last three quarters since sterling fell in the wake of the referendum vote. Industrial output slipped 0.1% and factory growth slowed to a three-month low, while the UK’s trade deficit increased by £1 billion in May – an increase far in excess of expectations. Whether the numbers offer an accurate reading of second-quarter UK growth, however, remains to be seen.

Nevertheless, such figures do give the Bank of England new reasons to think twice about raising interest rates. Last week the Bank passed a landmark: Wednesday was the ten-year anniversary of the last time it raised interest rates. Moreover, rising consumer credit and mortgage debt could push it in either direction. Gilt yields had been tracking upwards last week, but dipped somewhat on Friday following the economic releases. Despite energy stock declines, UK equities benefited from investors buying up financial stocks. The FTSE 100 ended the week up 0.5%.

Pension savers in the UK could take heart somewhat last week, given what the new work and pensions minister said in a speech delivered in London on Tuesday – his first significant public speech in his new role. In his address, David Gauke said that the government was unlikely to make any “fundamental” changes to pensions tax relief “in the near future”. Gauke was a minister in the Treasury back in 2015 when George Osborne suggested reforms that could have removed upfront pensions tax relief for higher earners. Gauke’s announcement appeared to reflect immediate political realities rather than a change of heart.

“Getting legislation through the House of Commons would be challenging now,” he said. “But that does give us an opportunity to now think about long-term reform.”

Those saving for retirement might want to take up the opportunity provided by the government’s apparent stay of execution – and continue to make the most of current tax reliefs. Savers should also note that the work and pensions secretary spoke only of avoiding “fundamental” reforms, thereby leaving the door open for smaller reforms. Speculation is currently focused on whether adjustments to the annual and lifetime allowances could be in the offing. There have already been more than ten such changes to the allowances since 2006 – there may therefore not be long to wait before the next round of allowance cuts. All the same, Gauke’s speech was largely good news for pension savers.

There was also good news for the City of London last week. A study published by the European Central Bank showed that London could not easily be replaced as a hub for European finance, in great part due to the undersea cables that link it to so much of the rest of the world. Some 43% of euro transactions outside the eurozone are currently conducted in London, and these have always threatened to provide a major flashpoint in negotiations. The report cited one study which had calculated that the cables had boosted London’s turnover by a third. As Donald Trump was so eager to emphasise in Warsaw, old ties break hard.

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